A Huge Threat to Frontier's Dividend

Oh, Frontier Communications (NYS: FTR) , please say it ain't so. Have you really been cheating your customers by padding their bills with bogus fees, as a class action lawsuit brought against you alleges? Just because most of your customers live in the sticks, are you treating them like naive bumpkins who would assume that whatever their phone and Internet service provider decides to charge would of course be legit?

Please tell us it's not true -- as the lawsuit claims -- that you added something called an "HSI surcharge" under the "state taxes and other charges" section of your customers' broadband bills, telling them it was either a required or an authorized governmental fee. The plaintiffs state that these are illegal taxes prohibited under the Internet Tax Freedom Act and the Federal Communications Act, as well as state laws. Their lawyer called the surcharge "... merely a junk fee that Frontier imposes on customers in order to inflate the price of its service."

I also hope that you did not -- as the suit further claims -- also impose 911 fees on your Internet customers. I mean, everyone knows you can't call 911 from the Internet, right? Oh, and did you also charge something called a Universal Service Fund fee? Those fees are also only for phone subscribers.

Other telecom lawsuitsFrontier isn't the only telecom to have been the target of legal action lately, not by a long shot. The DOJ has proven extremely active in the sector lately, the most notorious example being the Department of Justice's suit to stopAT&T (NYS: T) from acquiring T-Mobile USA on antitrust grounds. Sprint Nextel (NYS: S) , the wireless carrier probably most negatively affected by that potential merger, also sued to stop the deal.

And most recently, a group of PAETEC(Nasdaq: PAET) shareholders sued to stop the merger of their company with Windstream (NAS: WIN) . They claimed that the offer that PAETEC's board of directors accepted from Windstream unfairly valued the company. A rumor that Level 3 Communications (NAS: LVLT) was also interested in buying PAETEC also fueled the shareholders' belief that they should hold out for a higher price. But that suit settled last week, leaving the final disposition of the merger to a shareholder vote at the end of October.

What could happen?As an investor myself in Frontier, I have several questions regarding the above allegations.

First, if true, how much money could the company have squeezed out of its Internet subscribers? Let's see, the suit claims that the HSI surcharge added $1 to $1.50 to the monthly bills. As of June 30, Frontier had 1,715,119 high-speed Internet subscribers. So that would give the company an extra $1,715,119 to $2,572,678.5 a month in additional revenue ...

... or $20.6 million to $30.9 million annually. That surcharge certainly added up.

The second question is, if the high estimate of allegedly fraudulent fees collected annually were taken away from the bottom line, how would that affect Frontier's generous dividend? Frontier paid out $746 million in dividends during the last 12 months. Subtracting the $30.9 million in allegedly fraudulent fees would reduce the money paid out by 4.1%. That would reduce the current quarterly dividend of $0.19 a share to $0.18 a share.

At today's price per share of $6.06, that would bring the yield to 11.9%, down from 12.5%. That's only a difference of 0.6%, not huge.

Bottom line: big potential damagesBut if the allegations are judged to be true, Frontier would likely have to pay punitive damages on top of fee reimbursements. The law firm that is representing the plaintiffs states that "... damages could run well into the hundreds of millions of dollars." Obviously, if that happens, the company's bottom line and dividend would be adversely affected.

We'll have to wait and see if the $575 million line of financing that Frontier just received will be used for its original purpose of paying off three previous loans totaling $473 million, or if it will be needed to cover the potential costs of this lawsuit.